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The Bank of England hikes into an energy shock as Schnabel argues for reversible tools

Victoria Shinder2 min read

Three central bank documents from this week show how the post-pandemic experience is shaping the response to a new energy shock. On 5 November the Bank of England raised Bank Rate to 4% by an 8-1 vote, with one member wanting 4.25%. The same day, ECB Executive Board member Isabel Schnabel set out four lessons from seven years of policy. A day earlier, the Riksbank announced it will cut currency risk on its balance sheet with around SEK 200 billion of foreign currency loans.

The Bank of England's move is explicitly pre-emptive. Its minutes say direct energy effects account for about 1 percentage point of September's 3.5% inflation, that inflation should rise to around 5% by mid-2027, and that there is still limited evidence of second-round effects on wages and other prices; the Committee hikes anyway, citing pressure in the pipeline and stronger than expected activity. That is close to Schnabel's second lesson: respond to how a shock affects the inflation outlook, not to whether it is a supply or demand shock. Her account of the last cycle, in which the ECB was slow to see a regime change and models underweighted profit-driven inflation and a steeper Phillips curve, is the argument for not waiting for proof.

Her first and fourth lessons point the same way: keep instruments reversible, avoid forward guidance that ties policy to one view of the world, and run a balance sheet no larger than necessary. The Riksbank's plan is a small example of the same caution applied to a central bank's own finances, swapping a currency mismatch for matched foreign currency liabilities, spread over 12 to 18 months so that it is not mistaken for policy.

The Bank of England hikes into an energy shock as Schnabel argues for reversible tools
The Bank of England hikes into an energy shock as Schnabel argues for reversible tools — Rate Brief

What it means

The lesson central banks appear to have taken from 2021 and 2022 is that waiting for second-round effects costs more than acting early. Whether that holds will show in December, when both the Bank of England and the ECB meet with another month of energy prices behind them.

Written by Victoria Shinder.